Series LLC: Simplify Your Legal Entity Structure

Series LLC: Simplify Your Legal Entity Structure

By Ron Cohen, CPA, MST
Partner
Greenstein, Rogoff, Olsen & Co., LLP

Many businesses are being set up as a Series LLC where multiple projects are involved. Rather than setting up an entirely new Limited Liability Company (LLC) for each project, a Series LLC can be formed, with each “cell” in the series being legally independent. A lawsuit in cell #1 can’t make a claim against the assets in cell #2. For example, a client of mine is purchasing foreclosed properties in 30 states. We recommended putting each major property in a separate “cell” of a series LLC, reducing legal costs compared to a establishing a completely separate LLC for each major property. Then, a law suit in a New York cell can’t collect a judgment against assets in a cell in California.

As a CPA, I can’t practice law under California law, so please consult your attorney on this matter.

For the full story on California taxation of LLCs in general, please see: http://www.ftb.ca.gov/forms/misc/3556.pdf California has a very unfortunate (and some believe, unconstitutional) LLC “fee” on gross (not net) income that can be as much as $11,790 per year IN ADDITION to an $800 per year minimum tax.

Here’s a good article on the issue from Wikipedia on Series LLCs:

Series LLC

A series limited liability company, commonly known as a series LLC, is a special form of a limited liability company that provides liability protection across multiple “series” each of which is theoretically protected from liabilities arising from the other series. In overall structure, the series LLC is comparable to a corporation with several subsidiaries.

Many form an LLC in order to protect personal assets from a legal claim relating to their real estate investment or business liabilities. Additional liability protection may be gained by properly forming and maintaining a separate LLC to hold each property or business entity. By forming a separate LLC to own and hold each legally titled separate property or business entity, theoretically only the assets owned by a specific LLC would be subject to claims or lawsuits arising against that LLC. However there are costs and administrative burdens associated with properly forming, qualifying and maintaining each separate LLC. Another option may be to form a Series LLC, also known as a “cell” LLC, if permitted under applicable laws. Although each cell of a Series LLC can own distinct assets, incur separate liabilities, and have different managers and members, a Series LLC pays one filing fee and files one income tax return each year, if each series member is also a founding member of the LLC. When non-founding members are added to a newly created cell within the Series LLC, that new cell should file a separate partnership tax return for that cell. Furthermore, liability incurred by one unit does not cross over and jeopardize assets titled in other subsidiary units of the same Series LLC. Also, if a business owns real estate used in its operations, a Series LLC may avoid sales tax due on rent paid by the operating series to the real estate series. A Series LLC has been described as a master LLC that has separate divisions, which is similar to an S corporation with Q-subs.

The procedure for adding and deleting series is uncomplicated. Additional series can be added by simply amending the Series’ “limited liability company agreement” (equivalent to an operating agreement for other LLCs). Under Delaware law, any particular series may be dissolved by 2/3 approval of the ownership interests, or a simple majority if provided for in the operating agreement.

This method of liability segregation was first called the “Delaware Series LLC” because it was first approved in Delaware. As of April 2005, Iowa and Oklahoma already had passed similar acts. Illinois followed suit in August of 2005. Tennessee and Utah passed legislation effective in 2006. Wisconsin passed a stripped-down version of the series LLC legislation.

Acceptance by other jurisdictions

The series LLC is not more widely used as a liability segregation technique because its tax treatment has not been fully resolved and because its effectiveness has not been tested judicially. Currently, the federal tax standards for a Series LLC with multiple members remain unclear. Some speculate that single entity federal tax treatment will require highly correlated assets, members and managers (particularly the last two). On January 18, 2008, the Internal Revenue Service issued Private Letter Ruling 200803004, which ruled that the Federal tax classification (i.e., disregarded entity or partnership or taxable association) is determined for each series independently. So, for example, if there is only one owner of series A, then series A can be a disregarded entity (assuming it does not elect to be taxed as an association). And if series B has two owners, then it will be treated as a partnership. There is further speculation that California will only tax income from those series conducting business in California. Other states may follow. However, as of April 2006, The California Franchise Tax Board has determined that each Series of a Delaware Series LLC must report and pay taxes as a separate entity in California. Also, since the asset protection and planning advantages of the Series LLC have not been thoroughly challenged in asset protection cases, they remain theoretical, and unproven. To minimize the chances of one series being held liable for another’s liabilities, the owners of a Delaware Series LLC should do the following:

A separate bank account should be maintained for each series.
All contracts, deeds, notes, etc. should be signed in the name of the series. Again, use something like “Abracadabra LLC, Blackacre Series only”.
Any loans between series should be properly documented.
Any transactions between series should be conducted in an arms’-length manner at fair market prices using appraisals.
Have each series file a fictitious business name statement in each county where it owns property. Each series should have its own name and the filing should emphasize the ownership of that series, for example, “Abracadabra LLC, Blackacre Series only”. This is to put creditors on notice.
Keep the assets and operations of each series separate from the other series. Each asset should be owned solely by one series. In other words, two or more series should not be co-owners of the same property.
Make sure each series is adequately capitalized.
U.S. States where a Series LLC can be formed
Delaware (Limited Liability Company Act)
Iowa
Illinois
Nevada
Oklahoma
Tennessee
Utah
Wisconsin